kellogg annual reports 2003

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kellogg annual reports 2003

  1. 1. EARNING OUR STRIPES. ANNUAL REPORT 2003
  2. 2. NET SALES (millions) OPERATING PROFIT (millions) $8,812 $8,304 $1,508 $1,544 $7,548 $6,110 $6,157 $6,087 $1,168 $990 $895 $829 98 99 00 01 02 03 98 99 00 01 02 03 We again posted strong internal sales We were able to increase our operating profit in 2003 growth in 2003, driven by brand building while making substantial investments for the future. and innovation across our portfolio. EARNINGS PER SHARE (diluted) CASH FLOW (millions) $1,000 $1.92 $961 $1.75 Voluntary $856 Benefit Plan Contributions $1.45 $650 $1.23 $1.16 $529 $0.83 $346 $746 $924 98 99 00 01 02 03 98 99 00 01 02 03 We again delivered better-than-expected Cash flow again exceeded expectations, as we increased earnings growth in 2003. earnings, remained disciplined on capital expenditure, and improved our working capital efficiency. TOTAL SHARE OWNER RETURN In 2003, we earned our Kellogg S&P Packaged Foods Index stripes by delivering 26% 19% 17% solid results, while 15% 8% 5% 3% 2% strengthening our -7% organization and -11% -21% -29% creating a future of 98 99 00 01 02 03 dependable growth. For the third straight year, our total share owner return well outpaced our peer group.
  3. 3. 2003 ANNUAL REPORT With 2003 net sales of almost $9 billion, Kellogg Company is the world’s leading producer of cereal and a leading producer of convenience foods, including cookies, crackers, toaster pastries, cereal bars, frozen waffles, and meat alternatives. The Company’s brands include Kellogg’s ®, Keebler ®, Pop-Tarts ®, Eggo ®, Cheez-It ®, Nutri-Grain ®, Rice Krispies ®, Murray ®, Austin®, Morningstar Farms ®, Famous Amos ®, Carr‘s, Plantation, Ready Crust®, and Kashi ®. Kellogg products are manufactured in 17 countries and marketed in over 180 countries around the world. FINANCIAL HIGHLIGHTS 2003 Change 2002 Change 2001 Change (dollars in millions, except per share data) Net sales $8,811.5 6% $8,304.1 10% $7,548.4 24% Gross profit as a % of net sales 44.4% -.6 pts 45.0% .8 pts 44.2% .1 pts Operating profit 1,544.1 2% 1,508.1 29% 1,167.9 18% Net earnings 787.1 9% 720.9 52% 473.6 -19% Net earnings per share Basic 1.93 9% 1.77 51% 1.17 -19% Diluted 1.92 10% 1.75 51% 1.16 -20% Cash flow (net cash provided by operating 923.8 24% 746.4 -13% 855.5 32% activities, reduced by capital expenditure) (a) Dividends per share $ 1.01 — $ 1.01 — $ 1.01 2% (a) The Company uses this non-GAAP financial measure to focus management and investors on the amount of cash available for debt repayment, dividend distributions, acquisition opportunities, and share repurchase. Refer to Management’s Discussion and Analysis on page 25 for reconciliation to the comparable GAAP measure. TABLE OF CONTENTS 2 Letter to Share Owners 31 Selected Financial Data 8 Growing Our Sales 32 Consolidated Financial Statements 17 Improving Our Profitability 35 Notes to Consolidated Financial Statements 18 Turning Our Profit Into Cash 52 Management’s Responsibility for Financial Statements 19 Helping the Community 52 Report of Independent Auditors 20 Providing Nutrition to Our Consumers 54 Board of Directors 21 Living the K Values 57 Share Owner Information 22 Management’s Discussion and Analysis
  4. 4. TO OUR SHARE OWNERS It is a pleasure to write to you on behalf of over 25,000 Kellogg employees and our Board of Directors, all of whom are committed to making this great Company even more dependable than ever before. We know that a track record and reputation for dependability cannot be built overnight – we must earn our stripes each and every day, in all aspects of our business. That’s why I am so proud of our performance in 2003. We not only deliv- ered solid results again in a challenging environment, but we also took important steps toward creating our future and strengthening our organization.
  5. 5. Delivering Results Creating Our Future By any financial measure, we certainly earned our As good as our 2003 performance was, our goal is not stripes in 2003. to deliver one year of exceptional results. We believe the best way to create value for you is to deliver consistent, • Our share price increased 11% in 2003, even as in- dependable growth, year after year. This means contin- vestors shifted toward more economically cyclical sec- ually enhancing our capabilities and reinvesting in the tors of the stock market. Importantly, this share-price business. In 2003, we boosted our brand-building appreciation outpaced our peer group of large-cap investment by approximately 15%. We increased and packaged food stocks for the third consecutive year. improved our advertising, and we had a full calendar of Including dividends, our total return to share owners promotional campaigns designed to excite consumers. was more than 14% in 2003, well ahead of our peers. Additionally, our innovation efforts yielded promising The performance brought our three-year compound new products in all of our businesses. These activities annual return to almost 17%. This exceeds our peer strengthen our brands and create momentum for group’s 3% average over that same three-year period, the future. and it is well above the broader S&P 500 stock index, which declined an average of 4.5%. We also invested in cost-savings projects. Over the course of 2003, we rationalized capacity in several • Our net sales increased by 6% in 2003. Internal net countries and took steps to reduce overhead. These ef- sales growth, which excludes favorable foreign forts will generate substantial savings in future years, currency translation and the effect of two small but they required up-front investment in 2003, in the divestitures, was a solid 4%. This came on top of a form of asset write-offs and other costs. similar gain in 2002. This growth on growth, along with the fact that most of our portfolio shared in this As good as our 2003 performance was, our growth, is a sign of sustainability. For the 2001-2003 period, our compound annual growth rate for net goal is not to deliver one year of exceptional sales was 13%; on an internal basis, excluding results. We believe the best way to create currency and acquisitons, our growth averaged 3%. value for you is to deliver consistent, • Our earnings per share grew by 10% in 2003. This dependable growth, year after year. exceeded our high single-digit growth target, and even more impressive was the quality of these earnings. Through productivity initiatives and a favorable shift in We also shaped the future by improving our financial our sales mix, we were able to offset the impact of flexibility. In 2003, we reduced our debt by more than sharply higher costs, especially for raw materials, fuel, $550 million. We have now paid down $1.6 billion of and pension and health-care benefits. We also signifi- debt since the acquisition of Keebler Foods in March cantly increased our investment in brand building and 2001. This is an outstanding accomplishment, and one innovation, and incurred substantial asset write-offs, im- that reflects our focus on the generation of cash flow. pairments, and up-front costs related to improving We further created financial flexibility in 2003 by again future productivity. This growth amidst reinvestment is making voluntary contributions to our pension and another sign of sustainability. For the 2001-2003 period, retiree health-care benefit funds. These contributions our compound annual growth rate for EPS was 10%. raised our funding levels for these financial obligations, • Our cash flow* was $924 million in 2003, once and they mitigate future benefits expense. again ahead of our expectations. Driving this cash flow was not only strong earnings growth, but contin- ued improvement in our management of working cap- ital and good discipline on capital expenditure. We have become a far more efficient generator of cash. * Cash flow is defined as cash from operating activities less capital expen- For the 2001-2003 period, our compound annual ditures. Refer to Management’s Discussion and Analysis on page 25 for reconciliation to the comparable GAAP measure. growth rate for cash flow was 12%. Kellogg Company 3
  6. 6. Strengthening Our Organization • Putting the right people in the right jobs has been critical to our renewed success. In 2003, we made Our founder, Mr. W. K. Kellogg, was fond of saying “I’ll several transitions and promotions of key executives, invest my money in people.” In 2003 we launched or each intended to better leverage their strengths and continued various initiatives designed to invest more in to further develop their skills. our people: David Mackay, whose leadership drove the impressive • We launched an initiative called Talent turnaround of our U.S. businesses, was promoted to Management Worldwide aimed at building a more president and chief operating officer of the Company. comprehensive and systematic approach to David and I have complementary strengths and create identifying, training, and developing future leaders. a strong partnership in leading this Company. Our chief financial officer, John Bryant, has added to his • We conducted a Company-wide culture survey, responsibilities the leadership of our U.S. Natural & which helped us better understand the strengths and Frozen Foods division, giving John the experience of opportunities of our culture and environment. Every having business unit accountability. business unit, department, or corporate function is using the results to improve our employee satisfaction After very successfully leading the implementation of and become a better place to work. We plan to our Volume to Value strategy in international markets repeat the survey every two years. and driving strong sales growth in those markets, Alan Harris was named executive vice president, chief • We continued to hold workshops to spread marketing and customer officer. This is a new role de- the K ValuesTM, a set of guiding principles that signed to better implement the sharing of innovation were updated in 2002. In fact, most of our and marketing programs across the Company. management around the world has now participated in these sessions. Jeff Montie became an executive vice president of the Company, and Canada was added to his • We have formally made diversity and employee responsibilities. His leadership of our U.S. Morning safety priorities for 2004 and beyond. Our K ValuesTM Foods division has resulted in substantial growth call for us to show respect for and value all individuals and share gains, especially in cereal. Brad Davidson for their diverse backgrounds, experience, styles, ap- was promoted to senior vice president of the proaches, and ideas. The sustainability of our business Company, and put in charge of our U.S. Snacks divi- is dependent upon our ability to generate new ideas sion after successfully leading our U.S. Morning and to respond to consumers with changing Foods sales force. demographic profiles. Equally important is employee safety. High safety levels in the workplace are Several other executives were promoted in correlated with positive employee morale, strong pro- recognition of their strong contributions to the ductivity, and reduced costs. Company. Gary Pilnick was promoted to senior vice president, general counsel and secretary, and Celeste Earning Our Stripes 4
  7. 7. Clark to senior vice president with worldwide respon- category across the globe, giving us the best sibility for Corporate Affairs. Key general managers opportunity to expand consumption. When managed from around the world were named corporate officers well, we can generate strong, profitable growth in for the first time: Elisabeth Fleuriot, managing direc- cereal. In 2003, our U.S. cereal sales increased by 7%, tor, Kellogg France, Benelux, Scandinavia, South and our international cereal sales were up 4% in Africa; Juan-Pablo Villalobos, managing director, local currencies. Kellogg de Mexico; and Paul Norman, managing director, United Kingdom/Republic of Ireland. Their We believe it is a competitive advantage to promotions reflect the value of their personal contri- concentrate our resources on categories in butions and the strategic importance of these markets. which we have scale, expertise, and leading The result is a stronger organization: The right people in brands, as opposed to participating in a the right jobs; a commitment to develop tomorrow’s leaders; steps to create a safer, more diverse workforce; large number of categories that can distract and a winning culture. This, more than anything else, us from what we do best. will make us an even better company in the future. Expand Snacks. Snacks, and particularly wholesome Our Game Plan for 2004 snacks, continue to grow faster than other food categories. We are well positioned to participate in this and Beyond growth. We have strong, extendable brands and an ex- pertise in grain- and fruit-based foods. In the U.S. and We are in the enviable position of not having to create a Mexico, we have direct store-door distribution, giving us new strategy. We already have a game plan, an an in-store advantage. And wholesome snacks are usu- approach to the business that can achieve dependable ally located right in the cereal aisle. growth. Shaped by many people throughout our Company, it has evolved over the past few years into a In 2003, we showed continued progress in expanding simple and distinctly Kellogg plan. Our challenge now is our snacks business. Core international markets such to continuously improve our execution. as Mexico, Australia, and the U.K. showed strong dou- ble-digit net sales growth in snacks, and their innova- The game plan centers on the following priorities: tion pipelines are strong. Our success has attracted a lot of competition, and yet we have held our own in • Sticking to our Focused Strategy tough environments. We are a very focused company. Between cereal and wholesome snacks, the vast majority of our sales take In the U.S., while wholesome snacks have performed place in a single aisle of most stores and channels. We extremely well, they represent less than 20% of U.S. believe it is a competitive advantage to concentrate our Snacks’ sales. Their double-digit sales growth in 2003 resources on categories in which we have scale, expert- was offset by a decline in cookies sales, amidst weak ise, and leading brands, as opposed to participating in a category demand and price promotion by competitors. large number of categories that can distract us from A key priority for 2004 will be stabilizing our cookies what we do best. Our strategy underscores our focus: business, while maintaining share in crackers and grow- Grow Cereal, Expand Snacks, Pursue Selective ing wholesome snacks. Growth Opportunities. Pursue Selective Growth Opportunities. Beyond ce- Grow Cereal. Ready-to-eat cereal accounts for more real and snacks, we also participate in other nearby cat- than half of our Company’s net sales: That’s a good egories using strong regional brands. For example, in thing. Cereal is a large and profitable category that re- the U.S. we have Pop-Tarts®, #1 in toaster pastries; acts to brand building and innovation. It offers Eggo®, the leading frozen waffle brand; and consumers convenience, fun, and great taste, and it Morningstar Farms®, the largest frozen meat- contributes to a healthy, well-balanced diet. It’s also alternatives brand. Brands like these offer good, what we do best. We have leading shares in this profitable growth. Kellogg Company 5
  8. 8. We are also identifying new opportunities through and accounts payable). The improvements we have acquisitions, alliances, and innovation. These investments made in this area are remarkable, and we will continue will be in consumer-driven categories in which we can to enhance our working-capital efficiency in 2004. We’ll use our core competencies. These are categories in also remain disciplined on capital expenditure, prioritiz- which we can leverage our brands, supply chain, and in- ing resources for the highest-return projects and using novation expertise with grains and fruit. They also can existing assets whenever possible. With greater cash build on our existing customer relationships and channel flow, we can improve our financial flexibility over time and aisle focus. In 2003, for example, we extended by paying down debt, making contributions to our ben- Eggo® into the related syrup category, and Nutri-Grain® efit plans, making small tack-on acquisitions, or return- into granola. These required very little capital ing cash to share owners through share repurchases and investment and they leverage existing brands. dividend increases. • Adhering to our Financial Model The entire organization is intensely We continue to manage our business based on two sim- focused on executing our plans, earning ple operating principles: Volume to Value and Manage our stripes each and every day. for Cash. These principles are designed to create sustainable financial performance, and they are under- stood by the entire organization. While Volume to Value enhances and sustains our earn- ings growth, Manage for Cash ensures discipline over Volume to Value means adding value for consumers our capital base. Together, these principles increase our through branded, differentiated products – and getting return on invested capital. paid for that added value. It means focusing on sales dollars and not tonnage volume. It requires improving Another element of our financial model is realistic finan- our gross profit margin so that we may invest more in cial targets. When earnings growth targets are unrealis- brand building and innovation, drive our most valuable tically aggressive, business managers are inevitably com- brands, and grow our net sales. In 2003, we achieved pelled to make short-term decisions that may hurt their all but one of the underlying Volume to Value metrics. business over the long term. Such decisions could The exception was gross profit margin expansion, and include cutting brand-building investment, over- that was because we incurred investment costs related shipping to customers, or relying on price promotion. to future productivity initiatives. We expect to achieve Our goal is sustainable growth, even if it means target- all of the Volume to Value targets – including improved ing a more modest earnings growth rate. Our long-term gross profit margin – in 2004. growth targets are low single-digit net sales growth, mid-single-digit operating profit growth, and high Manage for Cash is the principle that focuses our single-digit EPS growth, and we will stick to these Company on generating cash flow. Each of our targets in 2004. We believe having these realistic targets businesses is working to reduce the amount of cash tied empowers and motivates our employees, and gives us the up in working capital (accounts receivable, inventory, flexibility to invest for sustainable growth in the future. Earning Our Stripes 6
  9. 9. • Leveraging our Leading Brands In 2002, we planned for a year of acceleration in sales and earnings, and we actually exceeded our targets that We are first and foremost a branded food company. We year. By 2003, our business was expected to exhibit mo- are not interested in participating in private label or low- mentum, and it did: We surpassed our sales and margin segments, where the economics do not allow us earnings growth targets while reinvesting for the future. to add value through brand building and innovation. Kellogg brands have several advantages. They are The success of these past three years is evidence that known and trusted in markets all over the world. They we are up to the challenge of generating sustainable extend effectively into close-in categories, such as earnings and cash flow growth in the future. The en- wholesome snacks, and they transfer easily across coun- tire organization is intensely focused on executing tries and regions. our plans, earning our stripes each and every day. Our goal is to be a dependable, long-term investment We will continue to leverage and extend our brands for you. We are grateful for your confidence in our across our geographic and product portfolio. Here’s a special Company, and we trust you are as optimistic great example of what we can do: In recent years, about our future as we are. Special K® cereal led to Special K® Red Berries cereal, which in turn, led to Special K TM bars. Today, Special K is a $500 million worldwide brand sold in 40 countries. • Utilizing our Worldwide Infrastructure It would require billions of dollars and many decades to even attempt to replicate our worldwide infrastructure. Moreover, because of our focused strategy, we have fairly consistent portfolios across the globe. We see this as an advantage for Kellogg. It enables us to transfer our best ideas quickly around the world, and across business units. These ideas can be proven innovations and brand-building concepts, but they can also include productivity enhancements and management processes and practices. We Are Up to the Challenge In late 2000, we laid out our plan to return Kellogg to sustainable growth. We changed our strategy and our organizational structure. The year 2001 was to be a year Carlos M. Gutierrez of transition. We purchased Keebler Foods, the largest Chairman of the Board acquisition in our history. We essentially overhauled the Chief Executive Officer entire Company while still achieving our earnings goals. Kellogg Company 7
  10. 10. EARNING OUR STRIPES We’re not just and that requires earning our stripes, too. We are contin- talking about ually identifying ways to be more efficient, rationalizing earning our our capacity, shifting our mix to more profitable business- stripes – we’re es, and controlling overhead expenses. Ultimately, the doing it. Every value of our Company – and your stock – is driven by the day, across the cash flow we generate. So, we earn our stripes by turning globe, Kellogg our sales and profit into cash, by limiting our capital people are deliv- expenditure to high-return projects, using existing assets ering results and wherever possible, and reducing the amount of cash we creating the have tied up in inventory and accounts receivable. These future. In the pages that follow, you’ll read about these are only the financial elements of dependability and sus- efforts, especially as they relate to sustaining our growth. tainability – we also must earn our stripes with our Growing our sales requires earning our stripes in so many employees, our communities, and our consumers. Simply ways: Improving our advertising and promotion programs; put, our entire organization is focused on executing our launching more, differentiated new products; finding new plans and making this an even better company tomorrow revenue streams within our focused strategy; partnering than it is today. with our customers and executing better in the store. To fuel our growth, we’ll need to increase our profitability, A. D. David Mackay President and Chief Operating Officer GROWING OUR SALES Our brand-building investment, which includes advertis- Expand Gross Profit ing and consumer promotions, increased at a double- Margin digit rate in 2003, substantially outpacing our net sales growth. This underscores our commitment to sustaining Grow Net Sales the strength and growth of our valuable brands. Not Increase only did we spend more, but we also improved the Brand VOLUME Building effectiveness of these brand-building efforts, as a focus to on execution and the sharing of proven ideas from VALUE around the world led to better programs. We also stepped up our innovation activity. Net sales from prod- Improve Mix ucts launched within the last three years again Drive Innovation approached 15% of total sales in 2003, an outstanding contribution. These product and packaging innovations The first step to sustainable cash flow growth is growing created excitement for consumers, leveraged our exist- our sales. Volume to Value has our entire organization ing brands and manufacturing capacity, and shifted our focused on profitable net sales growth, rather than on mix toward more profitable sales. Meanwhile, as we simply increasing tonnage. This means adding value to used brand building and innovation to drive demand, our products, through brand building and innovation, we were able to rely less on discounting, which further instead of relying on price discounts. It also means con- helped our net sales growth. centrating our marketing and sales resources on our Most encouraging is the fact that virtually all of our most profitable brands, as well as launching new prod- businesses in 2003 were successful in using Volume to ucts that have more favorable profit margins than our Value to generate profitable sales growth. portfolio average. Solid execution of this principle led to our strong 6% net sales gain in 2003. Earning Our Stripes 8
  11. 11. U.S. Retail Cereal We also benefited from new products. Fruit Harvest TM, Tony’s Cinnamon KrunchersTM, and SmorzTM were new Our U.S. Retail Cereal business had another outstand- brands launched early in the year, followed by brand ing year in 2003. It posted net sales growth of 7%, extensions like Maple & Brown Sugar Frosted Mini- even though it compared with a similarly strong 6% Wheats®, and Special K® Vanilla Almond. Our Kashi® gain in 2002. This growth on top of growth led to a natural cereal brand continued its strong growth, aided fourth consecutive year in which we increased our by new products like Organic PromiseTM Autumn share of the U.S. cereal category. That we can contin- Wheat TM, and Seven in the MorningTM; the latter serves ue to grow in a category considered to be fully devel- up a nutritional seven grains, seven grams of protein, oped is a testament to the power of brand building in and seven grams of fiber per serving. this business. U.S. Retail All Cereal Other U.S. Retail Cereal: Latin Am. Internal Net Sales Growth 7% 6% Europe 2% 2001 2002 2003 U.S. Retail Snacks Year-Over-Year % Change U.S. Other % of KELLOGG NET SALES These are all examples of bringing excitement to the In 2003, we continued to both increase and improve our category, adding value for the consumer, and contribut- advertising and consumer promotions in this business. ing positively to our key Volume to Value metrics. Our Strong advertising campaigns lifted several brands, such sales force continued to execute well at the store level, as Froot Loops® and Rice Krispies®. Apple Jacks® grew as our in-store representatives were successful at reduc- when children voted to add blue “carrots“ to the cereal. ing out-of-stock products and increasing feature and Disney® toys in the box helped drive growth in Kellogg’s display activity. The combination of all these efforts led Frosted Flakes® and Smacks®. A weight-loss campaign to sales and share momentum in our U.S. cereal busi- again lifted sales for Special K® and Special K® Red ness and reaffirmation of Kellogg Company’s position Berries. We launched promotional cereals and inserts as a key partner to our retailer customers. tied to popular movies like the “Cat In the Hat”, and holiday-themed versions of brands like Rice Krispies. Kellogg Company 9
  12. 12. Kellogg U.S. Ready to Eat Cereal: All Other Category Share U.S. Retail Latin Am. Cereal 34 33 Europe 32 U.S. Other 31 U.S. Retail Snacks % of KELLOGG NET SALES 30 2000 2001 2002 2003 impulse-driven wholesome snacks business, including Source: Information Resources, Inc.; Food, Drug & Mass channels, excl. Wal-Mart. Rolling 52-week periods. our Nutri-Grain® and Rice Krispies Treats® brands. Sure enough, the transfer to DSD has resulted in greater dis- We expect to continue to grow our U.S. cereal busi- play activity for these products while improving the ness. While it would be unrealistic to expect the same economics and effectiveness of our new-product kind of exceptional growth that we realized in 2003, launches. In 2003, we launched Cereal and Milk bars, we do project continued sales growth driven by brand leveraging some of our best cereal brands, and they building and innovation. In fact, we believe our 2004 quickly gained distribution, display, and consumption lineup of new products, advertising campaigns, and growth. Special K TM bars have been a great success, promotions is every bit as strong as that of 2003. continuing to post strong growth in 2003 despite com- paring against their previous-year launch. Late in the Kellogg U.S. Retail Snacks Sales at Retail year, we launched a new Nutri-Grain® Granola line. Wholesome Snacks Cookies Crackers –% Cookies -7% Wholesome Snacks +18% Portfolio –% Crackers Year-Over-Year % Change Source: Information Resources, Inc.; Food, Drug & Mass channels, excl. Wal-Mart. Year-to-date period through December 28, 2003. U.S. Retail Snacks In 2003, our U.S. Retail Snacks sales remained even Our California-based Kashi team certainly has been with 2002. However, the discontinuation of a less prof- earning its stripes. Kashi sales have quadrupled since itable custom manufacturing account, coupled with an Kellogg acquired the company in 2000. Its performance aggressive effort to eliminate stock keeping units has been clearly aligned with the principles of Volume (SKUs), meant the loss of about 2% of this business’ to Value, featuring investment in brand building and sales. These actions were designed to improve prof- innovation, along with focused execution. The result itability and to allow us to focus our resources on our has been increased consumer awareness and strong most valuable brands. positions in multiple categories. This has been a great success story driven by the teamwork and passion of Impressively, our wholesome snack brands collectively the Kashi team. posted strong double-digit sales growth in 2003. A key premise of the 2001 Keebler Foods acquisition was that #1 in $227MM 52% Keebler’s direct store-door (quot;DSDquot;) distribution system Category Dollar Share would profitably lift sales growth for the freshness- and Source; Information Resources, Inc., Food, Drug, and Mass Channels, excluding Wal-Mart; 52 Weeks ending 12/28/03. Natural Cereal Channel. Earning Our Stripes 10
  13. 13. Our crackers’ sales grew modestly in 2003. This was led Other U.S. Businesses by Cheez-It® crackers, the powerful brand we prioritized Our other U.S. businesses collectively posted internal for brand building and innovation. A new advertising sales growth of 3% in 2003. This group includes lead- campaign and several new product offerings, such as ing brands and alternative channels that present excel- Parmesan Garlic, Chili Cheese, and Sour Cream & lent opportunities for profitable growth. Onion, drove double-digit sales growth for Cheez-It in 2003. Not surprisingly, the cracker brands that received All U.S. Retail brand-building and innovation investment showed good Other Cereal Latin Am. growth. In addition to Cheez-It, we also experienced solid sales gains in our Club® and Toasteds® brands. Europe The only soft spot in our U.S. Retail Snacks portfolio in 2003 was our lower-margin cookies segment. Overall cookies consumption declined, amidst a relative lack of U.S. Retail Snacks brand building and innovation in a category that thrives U.S. Other on this kind of investment. Our decision not to follow % of KELLOGG NET SALES competitors’ price promotion activity resulted in less feature and display activity, further dampening our sales Pop-Tarts®, the leader in toaster pastries and our of this impulse-driven product. There is no question we largest brand in the U.S., achieved this year’s good need to battle more aggressively in the store and boost results despite new competitive entries and compar- the quantity and quality of our cookies’ promotion and isons with notably strong growth the year before. New innovation. As in crackers, the select cookie brands in products like Pop-Tarts® Yogurt BlastsTM offered deli- which we increased brand building and innovation did cious new alternatives to the traditional Pop-Tarts line show good growth in 2003: The E.L. Fudge®, Sandies®, and the “Chill ’Em” advertising campaign, which and Murray ® Sugar Free brands each posted retail sales urged consumers to try chilling Pop-Tarts, was a great and share gains. The priority now is to spread that success. Pop-Tarts sponsored the American Idol® tour, investment to more of our key cookie brands in 2004. and launched limited-edition Pop-Tarts for our “Cat in Our forecasts for 2004 incorporate only minimal sales the Hat” movie tie-in. growth from our U.S. Retail Snacks business. This is a Other U.S. Businesses: result of the impact of the discontinued custom manu- Leaders in Each Category facturing account and eliminated SKUs, along with competitors’ price promotion in cookies. However, we anticipate being able to defend our cookies position, #1 in $459MM 80% while maintaining our cracker sales and continuing to Category Dollar Share post solid growth in wholesome snacks. We have restructured our sales force and simplified the portfolio, #1 in $520MM 64% Category Dollar Share and we have planned a solid calendar of innovation, advertising, and in-store merchandising. Now it’s time #1 in $369MM 43% Category Dollar Share for execution, and we believe we have the brands, the distribution system, and the people to grow this busi- Source; Information Resources, Inc., Food, Drug, and Mass Channels, excluding Wal-Mart; 52 Weeks ending 12/28/03. Categories are ness for many years to come. Toaster Pastries, Frozen Waffles, Frozen Veggie Foods. Kellogg Company 11
  14. 14. We continued to expand the all-natural Kashi ® brand from the Keebler acquisition, we go to market in the beyond cereal. New flavors of Kashi® GoLean® snack bars foodservice, vending, and convenience-store channels were added to the line in 2003, and we had good first-year as a much stronger company. Good innovation and success with Kashi TLCsTM and KashiTM frozen waffles. sales efforts in 2003 allowed us to continue to gain share in the foodservice channel in all three of our Our Kellogg’s Krave® snack bars were launched nation- largest categories: cereal, cookies, and crackers. ally after two years in test market. This product offers con- sumers a delicious and more wholesome alternative to tradi- We project another year of profitable growth for tional confectionery bars, and gives us another opportunity in these other U.S. businesses in 2004. Each of these the supermarket aisle we love best—the one with cereal, toast- brand equities, as well as our food-away-from-home er pastries, and wholesome snacks. business, should benefit from new products and con- tinued emphasis on execution, both in brand building Other U.S. Businesses: and innovation. Internal Net Sales Growth 5% 3% 2002 2003 Year-Over-Year % Change We continue to generate growth in frozen foods. The leading frozen waffle brand, Eggo, grew on the strength of new products. These included line exten- sions like Eggo ® Froot LoopsTM frozen waffles, a limited edition Scooby DooTM frozen waffle, and new products such as Eggo® French Toaster Sticks. Late in the year, we extended the Eggo brand into a related category, syrup; this is an example of how we can add incremen- tal sales to existing brands without significant invest- Created only two years ago, our Ethnic Marketing ment or risk. Our meat alternatives business, principally Team has made great strides in reaching out to a under the category-leading Morningstar Farms brand, growing part of the U.S. population. In 2003, the also grew through innovation. New Morningstar Farms® team executed several successful promotions for this Parmesan Ranch Chik Patties®, for example, took market. One was our MUSI Kellogg’s Tour, an advantage of increasing consumption of non-burger Hispanic music tour. Similarly, the first Spanish-lan- products in the frozen meat alternatives segment. guage advertisement for our Special K® brand was a huge success, driving a significant increase in sales in The food-away-from-home channel was challenging for the Hispanic market. These efforts are good exam- most food companies during the past two years, but ples of earning our stripes in the marketplace. our business continued to grow. Benefiting from the increased scale and broadened portfolio that resulted Earning Our Stripes 12
  15. 15. Europe Europe: Accelerated Net Sales Growth Our net sales in Europe jumped 18% in 2003, or about 3% 2% 3% when adjusted for foreign currency translation. Our -2% longstanding presence in Europe, high category shares, and enduring brands generate solid returns on invest- 2001 2002 2003 ment. The implementation of Volume to Value in 2002 % Growth, Local Currency and 2003 led to accelerated sales growth for this region. All Other U.S. Retail Latin Am. Cereal Europe: Clear Cereal Leader Europe in All Key Countries RTE Cereal, Value Share Kellogg #2 U.S. Retail Kellogg Year Entered Ranking Share Share Snacks U.S. Other UK 1922 43% #1 17% FRANCE 1968 44% #1 27% % of KELLOGG NET SALES GERMANY 1950 26% #1 21% IRELAND 1929 56% #1 18% The U.K. is a notable success story. After implementing SPAIN 1977 52% #1 18% Volume to Value and building up an impressive pipeline ITALY 1967 56% #1 23% of innovations and consumer promotions, our cereal NORDIC 1957 39% #1 10% business in that core market picked up momentum in BENELUX 1970 52% #1 19% 2003. For the first time in years, it gained category Source; Information Resources, Inc., Food, Drug, and Mass share (+1.0 point). The innovation included the Channels, Latest 52-week period ended December 2003. relaunch of Kellogg’s Corn Flakes ®, using a foil inner bag to preserve freshness, and extending the brand with Kellogg’s Corn Flakes with Bananas. We also intro- duced Special K® Peach & Apricot and Crunchy Nut® Clusters, extensions of those two brands. Our calendar Europe: Regaining Share in Key Countries Value Share of RTE Cereal Category of consumer promotions was the most aggressive it had been in years. A themed cereal and a watch-in-the- 52 Weeks Change vs. 2003 Year Ago box insert were tied to the popular Simpsons® cartoon, UK 42.8% +1.0 and we ran promotions linked to Cartoon Network®, 44.2% +2.4 FRANCE Disney®, and the movie X-Men 2®. A weight-loss chal- lenge was again successful, as was a book offer and an Source; Information Resources, Inc. exercise-ball giveaway. We increased our advertising and made it better, especially on Frosties ®, Coco Pops®, Special K®, and Crunchy Nut ®. Meanwhile, we continue to expand our wholesome snacks business. We added Kellogg Company 13
  16. 16. line extensions and distribution to our existing brands, Latin America including new flavors of Cereal & Milk bars, Special K® Latin America remains our fastest growing region in the bars, Nutri-Grain® bars and Nutri-Grain® Minis, and world. We have leading category shares, a long-stand- Fruit‘N FibreTM bars. The U.K.’s results offer a great ing presence, and a strong local management team that example of what Volume to Value can do. is adept at managing through the volatility inherent in This same approach was taken in our other European that region. Per capita consumption of ready-to-eat markets, as well. We generated good growth in coun- cereal continues to grow, and yet remains well below tries like France, where our share of the ready-to-eat levels of developed markets. This points to sustainable cereal category rose more than 2 points, and in other category growth. Furthermore, rising disposable income markets like Spain and Italy, where cereal consumption and increased snacking suggests very attractive potential continues to grow. In each case, the gains were driven for our small, but rapidly growing wholesome snacks by better brand-building initiatives and more differenti- business in key markets of Latin America. ated innovation. Examples of brand building and inno- vations in Europe abound, both in cereal and in whole- Latin Am. All Other some snacks. We continued to roll out Special K® bars U.S. Retail Cereal into new markets, and we successfully launched new Special K® cereal flavors like Chocolate and Peach & Apricot. Reformulations, line extensions, and better Europe advertising have driven our Kellogg’s Extra® brand across Continental Europe. U.S. Retail Snacks In 2004, Kellogg Europe should again generate local- U.S. Other currency sales growth. Increased investment in brand % of KELLOGG NET SALES building and innovation should continue to grow cere- al sales in key markets, and we will continue to expand In 2003, Kellogg Latin America posted net sales our wholesome snacks business across the region. All growth of 2% in U.S. dollars, held back by currency the while, our emphasis will be on continuously devaluation. In local currencies, our growth was an improving execution. impressive 13% driven by both price/mix gains and tonnage. Both cereal and wholesome snacks posted double-digit growth. Mexico is by far our largest market in Latin America, and Kellogg de Mexico turned in another standout per- formance in 2003. Despite heavy competition from price brands and bagged cereals, our cereal business held its leading share, and posted double-digit net sales Earning Our Stripes 14
  17. 17. growth in local currency. As usual, Mexico’s growth was Latin America: driven by brand building and innovation on core Net Sales Growth Gets Stronger brands. Zucaritas® was lifted by a strong advertising 13 and promotion campaign, and Special K® rose strongly amidst another weight-loss challenge campaign and 7 line extension. We added a cappuccino flavor to our 5 All-Bran® line, and we executed numerous popular inserts and other promotions. Meanwhile, our sales of wholesome snacks in Mexico nearly doubled versus the 2001 2002 2003 prior year. In this relatively new category, we leverage % Growth, Local Currency our powerful cereal brands to expand our portfolio, and we use a DSD distribution system to extend our product availability. In 2003, All-Bran® snack bars con- tinued their strong growth, and we launched a handful Latin America: of Disney® snack products. Per Capita Consumption Ready-To-Eat Cereal In 2004, our Latin America business should again post Puerto Rico 4.3 solid sales growth, despite inevitable economic, curren- Mexico 1.5 cy, and political volatility in several markets. Cereal sales Costa Rica 1.1 should continue to benefit from new products, advertis- Panama 1.0 Guatemala ing, and consumer promotion, and we will continue to 0.7 Venezuela 0.5 expand our wholesome snacks business. Honduras 0.4 Chile 0.5 Argentina 0.2 El Salvador 0.5 Colombia 0.3 Dominican Republic 0.2 Brazil 0.1 Ecuador 0.2 Latin America 0.5 US 4.6 Total World 1.1 Kilograms Mexico: Leading Share The International Foodservice teams continued to earn Ready-To-Eat Cereal Category their stripes in 2003, posting a third consecutive year of significant sales growth. Competitors Key successes included Kellogg’s®cereals now being served in all McDonald’s® stores in Australia and New Zealand, Morningstar Farms® products making the 70% Kellogg menu in Subway® restaurants in Canada, and our UK Foodservice team being appointed category leaders in both the cereal and snack categories with the market’s three largest contract catering companies. Source: Nielsen Retail Index, Rolling 52 weeks, December, 2003 Good momentum and strong execution should mean continued growth in 2004. Kellogg Company 15
  18. 18. All Other Areas In Australia, cereal sales were aided by favorable price/mix, and by the launch of Special K® Peach & Apricot and a Simpsons®-themed cereal. Brand-building Our other international markets encompass Canada activities included a successful on-pack CD promotion and Australia, two of our largest markets, and Asia. In on Nutri-Grain® cereal and an effective advertising cam- 2003, this group of markets collectively posted sales paign behind our Sultana BranTM brand. Our snacks growth of nearly 18%, or 4% in local currencies. These business in Australia continued to post exceptional markets made strong progress on the Volume to Value growth, as we extend our portfolio and our distribution. metrics in 2003, enhancing their financial performance. Asia also posted solid growth. In Japan, growth was All driven by All-Bran®, behind an effective advertising Other campaign, and by a new Disney cereal. In Korea, a Lion King® on-pack CD and the launch of a new Almond U.S. Retail Cereal Latin Am. Flake cereal flavor led to good growth. Other International Areas: Europe Accelerated Growth 4% 2% U.S. Retail -2% Snacks U.S. Other % of KELLOGG NET SALES 2001 2002 2003 Year-Over-Year % Change, In Canada, we experienced growth in both cereal and Local Currencies snacks. Cereal growth was led by new advertising pro- grams on Special K ® and All Bran ®, proven campaigns Each of these regions and markets will focus on Volume on Kellogg’s Frosted Flakes® and Froot Loops® and new to Value in 2004. We should continue to build momen- product launches such as Hunny B’sTM, Tony’s Cinnamon tum in our innovation pipeline and our consumer promo- Frosted FlakesTM and a Scooby Doo-themed cereal. tions, allowing us to grow our cereal sales in the highly competitive Canadian and Australian markets, with faster The healthy snacks business in Canada was driven by growth coming from Asia. Our wholesome snacks busi- Special K TM bars and the introduction of new products, nesses in Australia and Canada should once again such as Rice Krispies Squares ® Bars with Cadbury® expand, taking advantage of favorable trends in snacking. Chocolate and Nutri-Grain Mini Granola Bites TM. Earning Our Stripes 16
  19. 19. IMPROVING OUR PROFITABILITY To be able to afford increased brand building and These factors are expected to raise our gross profit innovation investment, we need to improve our margin over time, even as we continue to face rising gross profit margin and control our overhead commodity, fuel, and benefits costs. Importantly, we expenses. In 2003, we improved our underlying prof- plan to use this improved profitability to reinvest in itability enough to invest for the future. While our our brands. When we refer to brand building, we reported gross profit margin declined modestly, this mean advertising and consumer promotion, not was largely due to investment. We incurred $70 mil- price discounting. In 2003, our brand-building lion of asset write-offs and other up-front costs relat- investment was increased at a strong double-digit ed to cost-savings initiatives; these are investments in rate, and we plan for this investment to again out- future profitability. We also increased the use of toys pace sales growth in 2004. in the box and other inserts, a form of consumer Our earnings growth in 2003 was of very high quali- promotion that is accounted for in cost of goods ty. It included the investment in brand building and sold. We faced higher costs in the form of commodi- cost-savings projects, as well as nearly $30 million of ties, fuel, and benefits, but we were able to offset other charges related to asset impairments and bond them with a combination of the following: repurchases that are not typical events. To post a • Increased net sales, which leveraged our fixed costs; strong earnings gain in the face of these signficant charges and investments suggests a very strong • A favorable mix shift toward our more profitable underlying profitability that can be used to drive products, thanks to the Volume to Value focus; growth in the future. • Synergies related to the Keebler acquisition, which reached their targeted level; • Ongoing productivity improvements, which we Gross Profit Margin have relentlessly pursued and achieved over the past several years. 45.0% 44.4% 44.2% Kellogg Company has 2001 2002 2003 a significant competi- % of Net Sales tive advantage in its global infrastructure. The decision to expand our business Investing in Our Business: internationally was Advertising Spending taken early in the $699 Company’s history and $589 was a far-sighted one. This scale allows us to take $519 advantage of global sourcing, decrease our input costs, transfer production and administrative functions between regions, and share best practices and ideas across all our markets. In 2003, our global packaging sourcing group, which has members around the 2001 2002 2003 world, instituted a broad program to coordinate the Millions sourcing of materials, adhesives, and cartons in many of our markets. This program is expected to dramati- cally improve efficency and save the Company millions Kellogg of dollars each year. Yet another way we are earning Company our stripes. 17
  20. 20. TURNING OUR PROFIT INTO CASH were growing. We expect to reduce core working Grow Net Earnings capital as a percent of sales again in 2004, albeit at Increase a more modest rate. Return on Invested Capital Disciplined Capital Expenditure Reduce Working MANAGE 6.0% Capital FOR 4.3% CASH 3.8% 3.7% 3.1% 2.8% Improve Financial Prioritize Flexibility Capital 1998 1999 2000 2001 2002 2003 Expenditure As % of Net Sales To create value for share owners, profit must be turned into cash. Our Manage for Cash principle has We’ve also remained extremely disciplined on capital the entire organization focused on doing just that. expenditure. In 2003, our capital expenditure was For example, in 2003, we reduced core working cap- approximately 3% of net sales, a level we believe is ital (12 months‘ average trade receivables plus inven- sustainable. Capital is not free, and this target tory, minus trade payables) as a percent of net sales ensures business discipline and higher returns on for the third consecutive year. This reduction of investment. When launching a new product, we look working capital has freed up millions of dollars of first to existing capacity. We seek ways to improve cash flow during those three years, even as our sales productivity, rather than simply purchasing new equip- ment. We expect to maintain this capital expenditure Fiscal 2003: Improving at 3% of net sales in 2004, as well. Working Capital 9.9% The result of these efforts has been strong cash flow 8.8% 8.7% 8.6% that has exceeded net income over each of the past 8.4% 8.2% three years. In 2004, we expect cash flow to again exceed net income. This strong cash flow allowed us to improve Dec. Dec. Mar. June Sept. Dec. our financial flexibility by paying down more than 2001 2002 2003 $550 million of debt in 2003, and to make another Core Working Capital cash contribution to our pension and retiree health- as % of Net Sales care benefit funds. In 2004, we will continue to pay * Based on last 12 months‘ average trade receivables and inventory, less trade payables, divided by net sales. Earning Our Stripes 18
  21. 21. down debt, but we will also use our cash flow in other ways. Last December, our Board of Directors approved an authorization to repurchase up to $300 million worth of Kellogg shares during 2004. We will also consider small, tack-on acquisitions, provided the valuation is attractive, and we can leverage our brands and supply chain. At Kellogg we recognize the critical importance of Improving Financial Flexibility diversity in our workforce and employee safety in $6.8 $6.2 our workplace. Success in enhancing diversity and $5.7 $5.2 employee safety will make Kellogg an even better company. In 2003, we took the additional step of formally including these initiatives in all individuals’ accountabilities for use in our annual performance March, 2001 December, December, December, reviews. This is another way we hope to earn our Keebler 2001 2002 2003 Acquisition stripes in the future. Outstanding Debt, in Billions As we increase our earnings (Volume to Value) and TM hold down our invested capital (Manage for Cash) our return on investment capital will continue to improve. This, in turn, improves our earnings, sus- taining the cycle. TM TM TM TM HELPING THE COMMUNITY At Kellogg, we are committed to giving back to our communities, and we proudly contribute to numerous local, national, and international charities. Our employ- ees contribute financially and with their time. Whether it is working to feed the hungry at a food pantry or building houses through Habitat For Humanity, we real- ize that we have an obligation to strengthen communi- ties. Our Company also recognizes this obligation through strong partnerships with local United Way organizations. In 2003, Kellogg and its people donated almost $2.9 million to local United Way campaigns in 22 U.S. communities. Our commitment to good citi- zenship also includes donations of food to hunger-relief United in Giving: Kellogg employees celebrate their record con- organizations around the world; in 2003, these dona- tribution to the United Way of Greater Battle Creek campaign. tions totaled more than $30 million. This $1.6 million contribution supports critical, community-based human services and includes a dollar-for-dollar company match of employee and retiree pledges. Kellogg Company 19
  22. 22. PROVIDING NUTRITION TO OUR CONSUMERS Rarely has there ever been so much nutrition news and information coming out at once. It can be very confusing. As recently as two years ago, we were told to avoid fats in general and saturated fats in particular. Then, last year, attention turned towards trans fatty acids, which had been used in many foods to replace saturated fats. We are fortunate to have the brand and product portfolio we do. Science supports the nutritional importance of whole grains and bran products. There are numerous studies that confirm that con- sumers who eat cereal for breakfast tend to have a lower body mass index than those who do not. Our wholesome snacks represent a healthier alternative evaluating our product line, looking for opportuni- to confectionery and other substitute products. We ties to selectively enhance certain products without are proud of our portfolio, and believe it offers a sacrificing taste and consumer acceptance. For wide enough selection of products and nutritional example, there may be opportunities to reduce or attributes that it can fit into any balanced diet and eliminate trans fatty acids, or to market products healthy lifestyle. that are low in carbohydrates, high in protein, or There is no question that obesity is reaching crisis low in calories. In summary, we will preserve our proportions in many countries around the world. reputation for providing wholesomeness, while giv- We can be part of the solution. We are currently ing consumers a choice. Earning Our Stripes 20
  23. 23. LIVING THE VALUES Every day, our employees demonstrate their commit- We Are Passionate About Our Business, ment to our corporate values. We take our culture seri- Our Brands And Our Food ously and provide ongoing training to constantly rein- • Show pride in our brands and heritage force our responsibilities to our customers, our commu- • Promote a positive, energizing, optimistic and fun nities, and to each other. This is nothing new to our environment Company; we have always followed these guiding prin- • Serve our customers and delight our consumers ciples in all our dealings. In 2002, we updated our val- through the quality of our products and services ues and instituted training programs that most of our • Promote and implement creative and innovative ideas management have attended. This program acts as a and solutions periodic reinforcement of our corporate values, across • Aggressively promote and protect our reputation the Company. We consider these values so important that we’ve again devoted to them a full page in our We Have The Humility And Hunger To Learn Annual Report. • Display openness and curiosity to learn from anyone, We Act With Integrity And Show Respect anywhere • Solicit and provide honest feedback without regard • Demonstrate a commitment to integrity and ethics to position • Show respect for and value all individuals for their • Personally commit to continuous improvement and diverse backgrounds, experience, styles, approaches be willing to change and ideas • Admit our mistakes and learn from them • Speak positively and supportively about team mem- • Never underestimate our competition bers when apart We Strive For Simplicity • Listen to others for understanding • Stop processes, procedures and activities that slow us • Assume positive intent down or do not add value • Work across organizational boundaries/levels and We Are All Accountable break down internal barriers • Accept personal accountability for our own actions • Deal with people and issues directly and avoid hidden and results agendas • Focus on finding solutions and achieving results, • Prize results over form rather than making excuses or placing blame We Love Success • Actively engage in discussions and support decisions • Achieve results and celebrate when we do once they are made • Help people to be their best by providing coaching • Involve others in decisions and plans that affect them and feedback • Keep promises and commitments made to others • Work with others as a team to accomplish results and win • Personally commit to the success and well being of teammates • Have a “can-do” attitude and drive to get the job done • Improve safety and health for employees and • Make people feel valued and appreciated embrace the belief that all injuries are preventable • Make the tough calls TM Kellogg Company TM TM TM 21 TM

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